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A Growing Divergence in Japanese Credit

There is an interesting divergence in Japanese credit. The premium on Japanese corporate credit swaps is wide compared to the premium on 5Y JGBs. There is a technical factor that needs to be baked into this spread. When iTraxx indices roll into new names, volatility is always to be expected as the new names comprising the index drive new marks. All the same, that 5Y JGBs are tightening and corporate credits are widening is speaks to something deeper at work than just technical factors.

The first is a decline in economic fundamentals almost surely related to the Chinese economic slowdown. This in turn causes a softening of Japanese balance sheets.

The second is that the latest round of BoJ monetary stimulus shows a decaying impact and there is no signal that additional easing is on the horizon.

The implications are clear. If you think the BoJ will step into markets with more easing, trade mean reversion. If you think there is no prospect of easing, then trade the momentum of weak corporates and a bid on the 5Y.

Japanese credit acts as the most liquid barometer of Chinese business investment and household consumption. The newsflow regarding Chinese demand continues to disappoint and I see no reversal in that trend either, Japan credit is bearing out the slow motion trainwreck.

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